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Abstract

This article investigates the determinants of insider trading regulation across countries. The article presents a political economy analysis of such regulation that takes into account both private (distributional) and public (economic efficiency) considerations. The model cannot be tested directly because the relevant private preferences and social costs are unobservable. However, existing theories of capital market development suggest that various observable social factors can explain the diversity of insider trading policies across countries. In turn, these social factors should reveal the underlying preferences and social costs motivating such regulation.

The main finding, based on data from a cross section of countries between 1980 and 1999, is that a country’s political system and not its legal or financial system provides the first-order explanation of its proclivity to regulate insider trading. Specifically, more democratic political systems enacted and enforced insider trading laws earlier than less democratic political systems, controlling for wealth, financial development, legal origin, and measures of latent social factors. In addition, left-leaning governments were relative latecomers to insider trading legislation and enforcement relative to right-leaning and centrist governments, controlling for the same factors as above.

The findings are consistent with the political theory of capital market development and inconsistent with the legal origins theory of capital market development. They also challenge theoretical claims that insider trading restrictions are market-inhibiting because the kinds of governments that appear more prone to regulate insider trading are precisely the governments that are generally thought to pursue market-promoting policies.